S&P, Downgrades And Idiots

Thoughts on, inter alia, finance, economics, and politics

This is not going to be one of those posts that laments S&P’s decision to downgrade the US, but then says that S&P was probably right about our oh-so-dysfunctional political system. No, S&P was flat-out wrong — no caveats. They are, to put it very bluntly, idiots, and they deserve every bit of opprobrium coming their way. They were embarrassingly wrong on the basic budget numbers, as everyone knows now, so they were forced to remove that section from their report, and change their rationale for the downgrade. (Always a sign that you’re dealing with hacks.) S&P’s rationale for the downgrade now is based entirely on their subjective political judgement — and their political judgement is wrong. The brilliant political minds over at S&P said that “the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges.” That sounds like a Very Serious and Sober assessment, but it’s really not. It’s true that the debt limit debate was ridiculous, and that a large contingent of Tea Party freshmen in the House were threatening to not raise the debt ceiling. But here’s the thing: we still raised the debt ceiling, and in such a way that this Congress won’t have the opportunity to use the debt ceiling as a political bargaining chip again. S&P’s assessment is only remotely serious if you assume that this particular Congress, with its huge contingent of crazy Tea Partiers, is going to serve in perpetuity. But this Congress isn’t going to serve in perpetuity — there are elections next year, and many of the Tea Party freshmen are likely to lose. They won in 2010 because it was a “wave election” in the middle of a very severe economic slump. But 2012 is a presidential election cycle with an incumbent Democratic president. A lot of these Tea Partiers who won in traditionally Democratic districts (and swing districts) are going to lose. In fact, it’s probably even odds that the Dems take back the House. The simple fact is that the Tea Partiers are almost certainly at the height of their power in this Congress. And no, the debt ceiling debate doesn’t reflect some sort of secular change in US policymaking — the next time there’s a Republican president, House Republicans will be all about raising the debt ceiling, and Democrats won’t engage in the same kind of political brinksmanship. You’d have to be stunningly naïve not to believe this. There have also been plenty of political de-escalations over the years — Republicans didn’t shut down the government every year after 1995, for instance. After Tom DeLay won the Medicare Part D vote by holding the vote open for 3 hours, everyone claimed that this would be the new normal on all controversial votes. Didn’t happen. There are plenty of one-off political confrontations. Simply assuming that every political confrontation represents a secular change in US politics and policymaking is ridiculous. (S&P tries to side-step this obvious weakness in their so-called “argument” by claiming that by the time the 2012 elections roll around, it will be too late. Please. The idea that we have to act in the next 18 months in order to meaningfully affect our long-term solvency is patently absurd.) Look, I know these S&P guys. Not these particular guys — I don’t know John Chambers or David Beers personally. But I know the rating agencies intimately. Back when I was an in-house lawyer for an investment bank, I had extensive interactions with all three rating agencies. We needed to get a lot of deals rated, and I was almost always involved in that process in the deals I worked on. To say that S&P analysts aren’t the sharpest tools in the drawer is a massive understatement. Naturally, before meeting with a rating agency, we would plan out our arguments — you want to make sure you’re making your strongest arguments, that everyone is on the same page about the deal’s positive attributes, etc. With S&P, it got to the point where we were constantly saying, “that’s a good point, but is S&P smart enough to understand that argument?” I kid you not, that was a hard-constraint in our game-plan. With Moody’s and Fitch, we at least were able to assume that the analysts on our deals would have a minimum level of financial competence. I’ve seen S&P make far more basic mistakes than the one they made in miscalculating the US’s debt-to-GDP ratio. I’ve seen an S&P managing director who didn’t know the order of operations, and when we pointed it out to him, stopped taking our calls. Despite impressive-sounding titles, these guys personify “amateur hour.” (And my opinion of S&P isn’t just based on a few deals; it’s based on countless deals, meetings, and phone calls over 20 years. It’s also the opinion of practically everyone else who deals with the rating agencies on a semi-regular basis.) Treasury has every right to be outraged. S&P mangled the economic argument so badly that they had to abandon it entirely, and then fell back on a political argument which they are in no position to make, and which isn’t even correct. So to S&P, I say: you should be ashamed of yourselves, and I truly hope this is your downfall.

Thanks for the insight about S&P. After the botch all the rating agencies made with the sub-prime bundling, I'm surprised anyone trusts what they say. If they can package liar loans as AAA, they ought to be able to rate Boehner and McConnell as AAA+ without batting an eye.

Some people criticize the anonymity enabled by the internet, but posts like these show that there are advantages as well.People with unique qualifications, like the poster, can let the rest of us know what really goes on inside institutions with immense power over all of our lives, without the fear they'll ruin their own careers.Nancy Irving

I want to dissent. There's no question that the decision was political and completely misguided or that S&P has a bad track record. However, the basic problem is that the US is unable to raise taxes. To actually raise taxes will require not just a majority in the House, but a supermajority in the Senate. That's not going to happen for a minimum of four years. Letting the Bush tax cuts on the wealthy expire will help.But that would require that the President win re-election and start standing up to Republican blackmail. So, the odds are that the tax situation will stay bad for at least 4-6 years-- or more. I think that S&P made a difficult call well. Let's not enter a state of denial about the state of our politics. We are in a state of Cold Civil War. --Charles

I totally agree with you and was surprised that the media did not question their change of tact more.

to anon at 8:09, I think you give FAR to much credit for any non financial news station (msnbc, cnbc, bloomberg). All of your morning news / today show etc have NO chance of noticing something that obvious

What do you mean by "the order of operations"? is this some fancy aspect of finance as most people don't need to worry about it ? Surely you don't mean first you multiply then you add.

Really, I'd like an answer to that question -- surely you do not mean the order of mathematical operations! sias

With anonymity, there are more arguments against than in favor of the S&P rating. I view that it's totally too early to assume that the whole financial market and it's agents will not react to the S&P's recently downgrade, although political and expected as mentioned here, given its presence for more than decades. The post seems to be a fictional story not backed by sufficient illustrations to show that S&P rating is not the one that US fiscal policy and so the policies of other governments should rely on from now. Yes, the market knows agencies biased ratings during recent crisis, but it is also surprising that there is still no any regulating authority to make them responsible and punished them for the great recession.

The downgrade creates a future upgrade day to boost consumer confidence and a political victory to the whoever is currently in office. The downgrade gives the rich more money for doing nothing while the American people have to work harder. The rich and banks have been taking from the "working" for generations (because they have never learned self control).

This is all about S&P trying to look like hard asses after, as the author of the OP points out, getting the entire decade wrong and playing the fools on Wall Street.

The rest of the world has had to watch on tenterhooks to see whether or not the US was going to default.That's not AAA.

"I’ve seen an S&P managing director who didn’t know the order of operations..."Could you clarify what you mean here please?

I believe that "order of operations" refers to the sequencing of events in case of a default or impairment of the credit instrument. Understanding the mechanics of a bond default allows proper estimation of "who pays" and "how much" -- which are the important things to bond buyers.

The ratings agencies have big problems because of how they get revenue. So, with regard to private debt there is some corrupting influence. When it comes to Sovereign debt, there is a lot of information out there for market to absorb without relying on ratings agencies. Also, the time to have shown concern about US debt was several years before the recession when we had all the bad trends but were at full employment. Unfortunately, most analysts are myopic, or occasionally ideological.

@phoenixwoman:Can't raise taxes? Maybe, but that's really irrelevant. Tax Reform (like that laid out in the Bowles-Simpson proposal from last year) could add $2T to $4T in revenue over the next decade, and that's just eliminating loopholes and lowering rates. The current administration could and should promise to let all the Bush Tax Cuts expire at the end of 2012 if Republicans do not come to the table to bargain for tax reforms that will provide the government with more revenue. The cuts expire unless they are extended by Congress, so there's not need to have any votes whatsoever to raise rates back to where they were under Bill Clinton. Your first paragraph is false. Whether the administration in fact WILL let those cuts expire or hold them over the head of the GOP to extract revenue generating concessions is a different animal entirely. But it does not take a majority in the House and a Super-Majority in the Senate to raise taxes. It takes one veto, that's it.

The ratings agencies lost all credibility long ago. Indeed they are idiots. If their employees were smart, they would be working on Wall Street.But if you are going to criticize them, it should be for keeping AAA ratings on crappy securities for way too long. That includes the AAA rating for the USA.The problem with the debt of the United States isn't that there is a ceiling, and the Treasury came perilously close to being unable to issue more debt to make interest payments. It's that the Treasury needs to borrow more money to pay back existing investors. It's that there is a massive official budget deficit. It's that the official deficit is tiny in comparison to the structural fiscal deficit due to off-balance-sheet obligations. The United States is, like most other countries, deeply insolvent. The gap between tax receipts and payments to Social Security and Medicare will within a decade or two reach tens of trillions of dollars - many times today's "deficit".None of this should be surprising. Lehman Brothers, AIG, Fannie Mae and Freddie Mac and others all had AAA, AA, A2 or very high investment grade ratings days before they declared bankruptcy or were rescued by the government. Mortgage-backed securities given A ratings by the agencies didn't just default - some of them were entirely wiped out.The ratings agencies get paid to perpetuate a vast illusion. Their job is to help the financial industry pretend that the bonds in pension funds are solid investments, when in fact they are bad loans that will not be repaid.Perhaps this downgrade will begin the unraveling of the illusion. When bond-holders start to sell, they will find there are no buyers, and the whole scheme will collapse.But perhaps it is easier to believe that everything is OK, and mighty America is exceptional, and remain ignorant and optimistic as the world collapses.

What do we think it's going to take for S&P to give us back our AAA rating? A budget surplus, or something else?

Only the author of the post knows for sure, but based on my own experience with the folks at S&P, I would bet the mortgage (pun intended) that, yes, he really is referring to someone who doesn't know something as simple as "first you multiply, then you add".Calling them "dim bulbs" would be a compliment.

While it's true that Democratic policies since FDR have turned the U.S. into a socialist cesspool which is unquestionably leading to U.S. economic decline, it's pretty remarkable that an organization like S&P, which apparently employs idiots exclusively, has somehow survived for 150 years.

I think SP has done now, what should have been done years ago.The US is run badly, arrogantly and without any concerns for sustainability.The US is bankrupt, face it. Buy gold!It is the end of fiat money, nothing less.

Yeah let's drain that socialist cesspool and go back to the days before Social Security when half of all elderly women lived in poverty. That will make us lean and competitive again.

Phoenixwoman said" To actually raise taxes will require not just a majority in the House, but a supermajority in the Senate."Reconciliation requires 50 votes.To actually raise taxes would require the Democrats to actually make the argument that we know from experience that voodoo economics doesn't work.

I think the downgrade is serious not for any directly economic reasons, but because it shows the political connections at work. Certain factions - which seem to be strongly represented on both sides of Congress and in the White House - want to lend weight to the "necessity" to impose economic austerity on the American people. This downgrade works to that effect.Quid Pro Quo: one wonders if this act was in payment for prior legislative favours to the rating agencies, or an investment in future favours?And yet again, the protected status of these agencies leads ineluctably to the type of incompetence discussed, for the same reason that congenital idiocy is no barrier to being King.

How is it that the debt ceiling cannot be used again as a political football? Didn't Geithner just agree to stay on as Treasury secretary because the administration feared that a new appointment to this post was going to be the next hostage taken by the Know Nothings in the Republican party?

This is the only rational thing I've read about the S&P debacle. And it's just my style. Bravo!

I think you wildly underestimate the failures of government in the US. It isn't just the Senate, which no longer operates on a majority rules basis. It isn't just the House, with the crazy party in control. Even if the Tea Party gets wiped out, control is vested in so few people that both houses are dysfunctional. This comment explains a lot: http://firedoglake.com/2011/08/07/standard-poor%E2%80%99s-downgrade-raises-one-legitimate-issue/#comment-2408970Every single regulatory agency is hamstrung by procedural rules and by unprincipled judicial oversight. The judiciary is full of ideologues whose leisurely pace insures that rules are in limbo for years even if they are eventually approved. For years, republican administrations put anti-regulation people into the system, sucking the vitality out of enforcement and regulation. Look at the SEC: no prosecutions for fraud in the biggest fraud in our history.There is no uncontested ground anywhere when one party makes it their sole political goal to screw over the President.Our government is thoroughly broken at every level. S&P is right about that.

I think its a big guess in thinking 'tea party' freshman will loose in 2012. Don't bet on it.

Economic crisis of the magnitude we are facing today does not develop in a vacuum, but due to collusion of interests to game the system. The question remains whether the rating agencies pattern of behavior over the last several decades was to willfully aid and abet these collusive interests, or whether they were simply just that incompetent. This accusation of collusion was made during the Carter's administration. At the time I thought it absurd that certain Americans would damage their own economy for political gain. Seeing the recent developments, and reflecting on the missteps of the earlier decades through the lens of accumulated experience, I am reaching different conclusion.

That is how you measure intelligence? That you couldnt sucker someone into accepting a structured finance deal like you could the other two agencies? Do you even remember when you sold out?

"But this is the United States of America. No matter what some agency may say, we've always been and always will be a triple-A country."... regardless of how much money we borrow or print. There, finished that for you.S&P is many years too late.

If the Tea Party does not lose, but gains members of Congress in 2012 will you admit you were wrong?If the economy totally collapses in the next 18 months, will you admit you were wrong?I will agree with one thing you said, that Republicans like to spend with a Republican president, but Democrats will never apply brinkmanship (because they always like spending.)

Several people have made this point already...However, a super-majority is not required to raise taxes in the Senate. 50 Senators (and the VP) will suffice. Tax hikes are subject to Reconsiliation and debate stops after 20 hours. Obama could have repealed the "Bush tax cuts", in whole or in part, at any time. He didn't.That makes them the "Obama tax cuts" and he has stated many times that he wants to keep almost all of them.

"No, S&P was flat-out wrong"Actually you are flat-out wrong.On what planet will discretionary spending only match GDP growth over the next 10 years?On what planet will a budget deal that cuts virtually nothing in 2012 but supposedly cuts a lot in 2021, actually reduce spending?When people say they will pay you on Thursday for a hamburger on Monday, you are supposed to know that it's a joke. A budget deal that promises lots of cheese in 2021 and near zero cheese in 2012, mean near zero cheese. Here is the number you really need to pay attention to. The 2011 estimated budget deficit is 10.8% of GDP. That's unheard of in the peacetime history of the United States and close to unheard of in modern economic history.We have been running gigantic deficits since Obama took office and no serious projection shows them declining any time soon (unless you believe a growth miracle is imminent). The S&P downgrade was fully justified.

I googled "order of operations finance" and "order of operations debt" and got nothing but mathematical order of operations, or the best way to increase your FICO score. Nothing about the seniority of debt for repayment in bankruptcy or anything like that.So I guess it is multiply then add. That is...sad. S&P must be absolutely terrible at hiring and keeping employees. I guess the only answer is that they're purely a sweat shop with relatively low wages and they make money because they get paid for ratings pretty much regardless of quality.

as someone who also has dealt with not only S&P but many other of the rating agencies I will also agree that they are complete and utterly useless idiots.There is no way they can grasp PEMDAS FOIL or anything along those lines, let o lone anything financial related. Often times yes, they were duped by people selling their useless toxic shit, but that just makes them bigger idiots because they knew they were being sold on BS.Even IF the US deserved to be downgraded doing it well after everyone says it so just makes you a sheep. They downgraded Bear hours before they were bought by JPM, LEH days before they were bankrupt. Anyone who thinks they are "doing the right thing" and not covering their asses is also equally stupid.Ratings are supposed to measure one thing, and one thing only. A CREDITS ABILITY TO REPAY ITS DEBT.Thats itnothing elsenothing morenothing lessNOTHING HAS CHANGED ON THE US' ABILITY TO REPAY DEBT. YES POLITICIANS ARE IDIOTS WHO CAN'T AGREE, AND EVEN THEY AGREED TO MAKE SURE THIS GOT DONE.

This reeks of (corrupt) politics. I would like to see the phone list of all the senior management over the last 6 years (yes, including the bush/chaney years).

@fourstick...I urge you to examine the following table and chart. Simpson-Bowles has some useful ideas, but on the whole it is completely oblivious to many actual problems. The US is the most likely taxed nation in the developed world. It spends the most on the military by far; . Deficits and military overspending have burdened it with enormous interest payments. It has weak demand, leading to low capacity utilization, because incomes at the bottom 2/3ds of the income spectrum have been stagnant or falling for a generation. The income situation is why there is such enormous debt. The Simpson-Bowles approach is designed by upper income people who apparently have no idea that 40,000 Americans die every year because they lack medical insurance, that a million or so are homeless, that the entire rising generation is being ravaged by social ills, poor education, untreated mental illness, and increasingly poor health. There are no cuts to give in the large entitlement programs. The US already has the worst so-called "safety net" of any industrialized nation. Many developing nations have better "safety net" programs. We deal with these issues in depth on my blog. I can offer you these leads to try to understand the situation, but can't take the time to do a full debate here. @Anonymous said... "Reconciliation [to raise taxes] requires 50 votes. To actually raise taxes would require the Democrats to actually make the argument that we know from experience that voodoo economics doesn't work."Actually, it would require the Democrats to change the Senate rules, which they are free to do, and have decided not to do. But then it would also take a cooperative House and President. --Charles

Wow. This is now officially the post I wish I'd posted on my my blog. S&P currently looks really stupid. They won't however admit to being wrong-- because that would mean confirming that what looks stupid really is.

If you have experience working at an investment bank, I'd like to ask you a fairly basic question on financial math: What kind of credit rating would you assign to a U.S. citizen with $50,000 annual income and $350,000 debt?I ask because the U.S. pulls in roughly $2 Trillion each year and is $14 Trillion in debt, approximately the same debt to income ratio. The math seems pretty simple, and I don't really think that you can expect to screw the "rich" out of a cool Trillion each year to pay that down. So, why should an entity that is clearly unable and unwilling to live within its means maintain a top-tier credit rating?

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